Figure 4: Low unemployment regions suffered from the crisis more than high unemploymentregions.......................................................................................................................................

21

Figure 5: Manufacturing, trade and tourism sectors were most affected by the crisis

Figure 15: Simulated Increase in the Number of Poor Individuals in 2009 by Education Level (15+)

.

36

Figure 16: Simulated Poverty Incidence for Children

.....................................................................

37

Figure 17: Simulated Poverty Risk by the Number of Children (0-6 Years Old) in the Household

......

37

Figure 18: Unemployment benefit is mostly received by the poor and lifts them out of poverty

......

40

Figure 19: Croatia spends on labor market programs substantially less than EU countries includingthe New Member States (EU10); accordingly program coverage is low

..........................................

42

Figure 20: The relative importance of training and public works programs increased during the crisis..................................................................................................................................................

43

Figure 21: Some local Employment Offices are much more effective in collecting information on jobvacancies than others

This report analyzes the impact of the global economic crisis on the labor market andpoverty in Croatia, and discusses the effectiveness of social safety netpolicies in response to thecrisis.

It also presents options to enhance the cost-effectiveness of social policy in Croatia inresponse to an economic downturn.

2.

Demand shocks and cyclical downturns will occur also in the future in Croatia, as in everymarket economy.

The analysis of the effectiveness of social policies in Croatia is thus meant to begeneral and not limited to the current crisis.

The turnaround of the Croatian economy is already insight and thus the policy focus is likely to shift from crisis related to structural policies.

However it isimportant to ensure that employment and social safety net policies are designed so as to be able totackle the rapid increase in unemployment and vulnerability to poverty resulting fromthe likelyfuturedemand shocks.

3.

The impact of the global economic crisis on the labor market in Croatia has beensubstantial.

Although the initial reaction of employment to the fall in output was modest, the paceof job destruction has accelerated over time.

In January 2010employment in the corporate sectorwas over 7 percent lower than before the crisis.

Thus the fall in employment paralleled that of GDP(close to 6 percent).

4.

The accelerated pace of job destruction has led to the increase in unemployment.

Thenumber of registered unemployed is currently (as of December 2009) about one third higher thanbefore the crisis and over 20 percent higher than a year earlier.

The crisis has reversed thesubstantial reduction in unemployment that occurred in 2007 and in the first half of 2008, andmoved the Croatian labor market back to the high unemployment state.

5.

The increase in unemployment in Croatia, although substantial, was still less than in mostEU countries.

The ILO/LFS unemployment rate increased in Croatia by 2.3 percentage points in 2009,compared with the average of 4.1 percentage points for the EU.

However, currently theunemployment rate in Croatia is slightly higher than the EU average (10.6 percent and 10.2 percent,respectively).

6.

In addition to an increase in unemployment,

the fall in labor demand has also led to a fallin the labor force participation rate.

Some workers facing the poor employment prospects becomediscouraged and withdraw from the labor force.

Real wages remained virtually stagnant once the economy slowed down and recently(since September 2009) started to fall.

Currently (December

2010),

the average real wage is nearly 38

percent lower than it was a year earlier.

The reduction of wage pressure helped to cut labor costsand thus to limit the layoffs.

Wage flexibility has thus emerged as an important crisis impactmitigation mechanism, which is a notable new phenomenon because until recently wage pressurespervaded the Croatian economy and were contributing to high unemployment.

8.

In contrast, few employers reacted to the fall in product demand by cutting working time.

The number of hours worked has remained roughly constant since

the crisis has begun, althoughmost recent data (October 2009) show some reduction in working time (4 percent).

Nonetheless,working time reduction does not seem to be an important adjustment mechanism in Croatia.

9.

In response to the fall in product demand

employers have also reduced hiring.

The numberof job vacancies plunged by around about one-third during the crisis.

This implies a dramaticworsening of job prospects for the unemployed, as measured by the unemployment/vacancies (U/V)ratio.

During the crisis the U/V ratio doubled in Croatia as a result of both a sharp increase inunemployment and an equally sharp fall in the number of job vacancies.

Currently there are 22newly registered unemployed per every 10 newly registered vacancies, whereas before

the crisisthere the ratio was only 11.

This implies that there are no job vacancies for the majority (55 percent)of the newly registered unemployed.

10.

Some of the Croatia’s regions have been hit much harder by the crisis than others.

While insomeregions unemployment increased by only around 10 percent in last year, in other it increasedby over 35 percent.

Regions where unemployment was initially low have been hit harder by the crisisthan regions where unemployment was high.

The impact of thecrisis in low unemployment regions has been thus significantly stronger than in high unemploymentregions.

As a consequence, the variation in the unemployment rate across regions is presently muchsmaller than before the crisis.

Thus the crisis has acted as a labor market equalizer.

11.

The way regional labor market reacted to the crisis reflected differences in regionalindustrial structures.

Industries that were most affected by the crisis include manufacturing, trade,tourism and construction.

Accordingly, regions where these industries play a dominant part sufferedthe most from the crisis.

The differences in regional industrial structure also explain whyunemployment has increased more in initially low-unemployment regions.

In Croatia regions whereunemployment was low before the crisis were either regions with a large share of manufacturingand trade industries, or regions relying on tourism.

Given that the crisis affected mainly theindustrial sector, labor market conditions in industrialized regions deteriorated more than in lessindustrialized, agricultural regions, where unemployment was initially higher.

12.

The industrial profile of the crisis translates into the socio-economic profile of affectedworkers.

Compared to the unemployment profile before the crisis, a newly unemployed person ismore likely to prime-age skilled blue-collar male worker.

Women, youth and white-collar workersare less affected by the crisis.

However, the differences in socio-economic profile between thosewho became unemployed before the crisis and those who became unemployed following the crisisare not that much pronounced.

Still they have significant poverty implications.

This is because thecrisis disproportionately hitprimary earners

(prime-age men), who are likely to be household heads.

In contrast, before the crisis it was predominantly secondary earners (youth, women) who bore thebrunt of labor market adjustment.

Unemployment of a primary earner is more likely to push ahousehold into poverty than that of a secondary earner.

9

13.

The simulations indicate that

the

fall in labor demand engendered by the crisis and theassociated increase in unemployment havehad

If so, then thecrisishas undone gains in socialwelfare achieved during the last few years of economic growth.

14.

Before the crisis absolute poverty was low in Croatia.

It was also shallow.

There werepockets of deep poverty but extreme poverty was rare.

Relative poverty was also low thanks torelatively low income and

consumption inequality.

Poverty was concentrated among older and lesseducated persons who were economically inactive or unemployed and lived in rural areas.

The crisischanged this profile.

15.

The lower middle-class was hit hardest by the consumption decline, although thedifferences between income groups are relatively small.

The very poorest population observed amilder consumption drop than the average population due to the fact that (i) they were not hit bythe employment decline; (ii) a policy of waivers and exemptions for lower income households werein place; and (iii) social transfers increased in 2009 (pensions, social assistance benefits).The largestdrop in consumption was observed by the second quintile, followed by the third quintile, indicating

thereby that lower middle class suffered the most during

the crisis.

16.

The increase inpovertyduring the crisis is largely due to the fall in consumption and to alesser extent due to an increase in inequality.

Inequality increased during the crisis,

thuscontributing to the increase in poverty, but this effect played a minor part.

17.

Povertywas predicted to increase

somewhat faster in richer urban areas than in poorerrural areas.

As a result, the share of urban population in the poorest quintile increased.

However,given that the bulk of the poor live in rural areas in Croatia, in absolute terms the increase in povertyin rural areas was considerably larger than in urban areas.

This pattern of poverty increase

reflectsthe fact that employment declined mostin more developed, industrial and urban regions of Croatia,while less developed rural regions were less affected by the crisis.

18.

Persons atrisk of povertypredominantlyare thosewho lost their jobs in the wake of thecrisis.

Accordingly, they tend to be

economically active (looking for new jobs), better educated andyounger than the “old poor”.

Their poverty is more likely to be transitory, closely associated with thetemporary worsening of labor market conditions.

The“new poor”

have a good chance to escapepoverty

once job prospects improve.

This is less likely in the case of the “old poor” whose povertyusually of long-term nature and associated with economic inactivity, poor skills and old-age.

19.

The crisis has negatively affected children.

The incidence of poverty among children isexpected to increase more than for the general population.

The most vulnerable are the multiple-children families.

20.

The policy response to the crisis has been limited.

The only safety net program whosecoverage hassignificantly increased during the crisis is unemployment benefit, acting as anautomatic stabilizer.

Active labor market programs, which are meant to help job losers to find newjobs, have extremely low coverage in Croatia (lower than in any EU country),and were further

1

Throughout the text we refer to thesimulated

poverty impact rather thanactual

impact. Accordingly,persons who are referred to as the “new poor” should strictly speaking be referred to as “potentially poor” or“at risk of poverty”.

10

downsized during the crisis due to the fiscal constraints.

The only active labor market program thatwas significantly expanded during the crisis ispublic works, but still it covered only a small fraction ofthe unemployed.

The number ofrecipients of the means tested social assistance program (known associal welfare support) has so far not increased.

After all, the coverage of the program is currentlylower than before the crisis.

However, the coverage of the social welfare support program is likely toincreases after some time-lag, once the recipients of unemployment benefit exhaust their eligibility(15 months maximum duration).2

21.

In the mid-2009 the government introduced a new program of short-time work subsidyintended to encourage working hours’

adjustment and discourage lay-offs.

However, the programhas had virtually no impact on employment because of an extremely low take-up rate by employers.

As a result most programs are not well targeted at thepoor and the “elite capture” is considerable.

24.

The effectiveness of thesocial protection system

in Croatia could be significantly enhancedwithin the existing resources envelope.

This would require streamlining and consolidatingnumerous social protection

programs, and altering the program mix by reallocating resources awayfrom poorly targeted andineffective programs towards the ones that are well targeted and have asignificant impact on poverty.

25.

As regardsemployment

policies, specific reform options include:



Scaling up effective labor market programs.

Currently the size of labor market programs

istoo small in Croatia to have an impact on labor market conditions.

Accordingly, theprograms would need to be substantially expanded in order to effectively mitigate theemployment effects of economic downturns.

However, only those programs should be

2

The duration of unemployment benefit receipt is unlimited for persons whose length of service exceeds 30years for women and 35 years for men.

11

expanded which are cost-effective, and are found to have a significant net impact on laborforce status of the participants.



Adjusting program mix to the changing labor market conditions.

During the economicdownturn

the government could consider scaling up programs that compensate for weaklabor demand.

This may be accompanied by temporarily scaling down programs meant toaddress structural unemployment in order make labor market expenditures fiscallysustainable.



Adjusting regional allocation of ALMPsfunds.

The government may consider developing analgorithm for adjusting the regional allocation of ALMPS funds to the changing labor marketconditions.

Regions where unemployment increased more would receive a higher share offunds than regions where it increased less.

However, for this approach to work effectively,an increase in funding would need to be coupled with an investment in the region’s capacityto absorb the increased funds.

26.

As regards social assistance, theshort-term

reform options (some ofwhich are alreadybeing considered by the Government; see) include:



Improving the spending mix to protect the poorest during the downturn.

Increasing the shareof social expenditures for thewelfare support allowance

could improve the capacity of thebest

targeted program to reach more low-income families.To increase the allocation forpoverty-focused programs within the spending envelope, the budgetary basis for determiningcategorical benefits could be frozen and budget expenditures (or taxes foregone in the case ofchild tax allowance) from other non-contributory social protection programs redirected to themeans-tested support allowance program.



Reducing in the number of categorical benefits.

Measures to streamline and simplify benefitsare importantfor increasing the efficiency and quality of the social assistance programs.Stepsin this direction were already taken in 2009 and

some of untargeted categorical programshave been discontinued.



Improving targeting.

The good practice of using means-testing for thewelfare supportallowance

could be used as a basis for targeting other benefits, including family benefits andthose in the health insurance and war veterans. This would reduce the risk of underestimatinghousehold income due to informal labor arrangements and underreporting of income or thatof providing support to client categories that are not needy.Means-testing procedures couldbe extended to family benefits and those in the health insurance with the application of thenewly introduced Personal Identification Number (PIN), which is a valuable tool for a betterallocation of resources from categorical to income-tested programs.



Simplifying benefits.

Measures to streamline and simplify benefits are important for increasingthe efficiency and quality of the social assistance programs. It is also important for improvedmonitoring and evaluation of the results of these programs.

The most desirable option wouldbe to establish a single, unified welfare benefit

administered by one central agency/ministry.

27.

In themedium-term

the reform priorities include:



Developing activation policies to reintegrate the long-term unemployed welfare recipients intothe labor market.If well designed, the proposed increase in expenditures allocated to targetedsocial assistance programs should not create poverty traps and overreliance on socialassistance, but instead provide beneficiaries an incentive to return to the labor market. Thiscould include targeting active labor market measures (employment subsidies, labor markettraining, and measures to promote jobs for disabled workers and youth) to the long-term12

unemployed and long-term social beneficiaries. Intensifying “activation” measures for thosegroups, including by introducing compulsory job-search workshops and by improving the basicskills of the long-term unemployed recipients of welfare

would help them

reconnect with theworld of work.



Improving the cost-effectiveness of pro-birth policies.

A number of potential measures, provedeffective in other countries with the similar level of development, can be considered. As therisk of poverty is positively correlated with the number of children, the targeting of the childallowanceprogram can further be improved, if the allowance would be reallocated towardsfamilies with more children. Such measure will not only support the equity objective pursuedby the Government, but will strengthen the pro-natality focus of the allowance, given thatsuch monetary incentives tend to be effective in protecting the living standard of low-incomehouseholds.



Addressing institutional fragmentation of the social safety net system at central and locallevels.

Currently, Croatia operates a complex system for policy development, implementation,monitoring and evaluation, which acts as a bottleneck to a cost-effective social protection andsocial assistance system. The number of programs on offer, the number of institutionsinvolved, and the lack of harmonization on eligibility criteria lead to a costly system toadminister, confusion, and errors of exclusion and inclusion which negatively impacts value formoney. The Government may consider consolidating administration to the extent possible bymerging relevant functions under fewer ministries, and/or single offices at the local levels witha view to easing access to social assistance programs, integrating social policy with efforts toaddress low labor force participation and ensuring more coherent planning.



Upgrading the social assistance information system. The planned Management InformationSystem in the social sector needs to implement linkages to the other government informationsystems that are already available or are in the planning phase. In addition, linkages or clearmechanism of information exchange should be established with the social assistance systemsof local governments as well as with the employment bureau, if Croatia aims to strengthen thepoverty impact of social spending by improving geographic targeting through increasing theprogram coverage rates in poorer regions. Improving information-exchange system would alsocut the administration cost and would reduce errors of exclusion and inclusion.

13

Box1:Government April 2010 Economic Recovery Program

I n Apri l 2010, the Government of Croati a adopted the Economi c Recovery Program al ong wi th the detai l edacti on pl an for i ts i mpl ementati on. The acti on pl an contai ns many of the

measures that, i f i mpl emented, wi l lcontri bute to a si gni fi cant i mprovement i n the effecti veness and effi ci ency of the l abor and soci al pol i ci es.Some of the acti vi ti es enl i sted i n the program fol l ow:

•

Focusi ngempl oymentpol i cy on professi onal educati on,

educati on, pre-qual i fi cati on and adopti on ofkey competences especi al l y for unempl oyed and

I ntroduci ng a system of vol unteeri ng, apprenti ceshi p, work practi ce, and i nternshi p so that the youngwoul d acqui re the fi rst work experi ence;

•

Strengtheni ng the capaci ty of the Croati an Empl oyment Bureau (i n parti cul ar wi th regard to careerdevel opment counsel i ng and i nformati on) and l i nki ng i ts work wi th the work of the Centers for Soci alWel fare and the Vocati onal Educati on and Adul t Educati on Agenci es;

•

Consol i dati on of the i mpl ementati on and oversi ght over the i mpl ementati on of al l empl oymentprograms i n one pl ace (Croati an Empl oyment Bureau);

•

Extendi ng the durati on of the enti tl ement to cash assi stance for the unempl oyed at ri sk of long-termunempl oyment;

•

An anal ysi s of the soci al benefi ts system, equal i zi ng of benefi ts awarded on the same basi s, and ful li mpl ementati on of OI B as an i nstrument for targeti ng soci al pol i cy measures;

•

Proposal for rati onal i zati on of soci al benefi ts, defini ng the common defi ni ti on of a fami l y (househol d),common methodol ogy for establ i shi ng ofmeans-testi ng census and the proposal ofvari ous programs’el i gi bi l i ty census;

An economic crisis quickly turns into a social crisis: workers lose jobs and earnings, and their familiesfall intopoverty.

This report looks at the social impact of the current global economic crisis inCroatia, in particular on labor market and poverty.

It first examines the labor market effects of thecrisis and then it analyses the consequences of labor market developments for poverty.

It alsodiscusses the policy response to the crisis, and considers options for revising labor market and socialassistance policies in Croatia so as enhance their effectiveness in addressing the adverse socialeffects of cyclical downturns.

The ultimate objective of the report is thus to contribute to thedevelopment of effective, evidence based social protection policies in Croatia.

The report finds thatthe impact of the crisis on employment has been substantial

in Croatia.

Unemployment has increased sharply,although less than in most EU countries.

The decline inemployment was coupled by a fall in real wages.

The crisis hit hardest prime age skilled blue-collarworkers in industrialized regions of the country.

These negative labor market developmentstranslated into the growing poverty, especially among working households.

Simulation resultssuggest that the crisis has undone welfare gains achieved in Croatia in the last few years.

Poverty isestimated to increase by around 30 percent

but from the comparatively low basis before the crisis.

The policy response to the crisis was limited.

Unemployment benefit was the first, and in fact theonly, line of defense.

However, many of the new jobless are not eligible to unemployment benefit.

Active labor market programs play a very limited role in Croatia and, due to the fiscal constraints,were further downsized during the crisis.

But the increase in the number of social assistance clientshas been very modest so far.

The report argues that within the existing resource envelope theefficiency of the social safety net in Croatia could be significantly enhanced byreallocating resourcesand improving the program mix, and by streamlining and consolidating the programs, includingbetter targeting.

The report is divided intofive

sections.

Section I provides a backdrop for further analysis bypresenting recent macroeconomic developments. Section II looks at the labor market effects of thecrisis.

The main ones were the fall inGDP of almost 6 percent in 2009, and mounting

fiscal pressures.

The fall in GDP led to the fall inlabor demand and triggered lay-offs, which in turn caused unemployment growth.

Fiscal pressures,in turn, limited the scope for expanding social protection programs in response to the crisis.

Economicenvironmentswiftly turnednegative

2.

Croatia enjoyed strong economic growth for almost a decade.

Growth, which averagedover 4 percent, was driven primarily by domestic demand. The non-tradable sector, such as retailand construction as well as tourism, wasbenefiting the most from the rapid rise in domestic andforeign demand over that period. This high growth performance led to a rapid convergence with theEU in per capita income terms so that Croatia reached 63 percent of the EU27 GDP per capita (in PPSterms) by 2008.

Average annual employment growth was 2.2 percent, led by services and manufacturing sectors.

Consequently, unemployment declined by 40 percent with theunemployment rate cut by one-fourth3. In fact, by end-2008, a key policy dialogue was focused on addressing skills shortages andincreasing comparatively low labor force participation that became an obstacle for further growth.Skills mismatches, as indicated by the abnormal share of long-term unemployment, were the maincause of still stubbornly high unemployment. As the labor supply became scarce, in an environmentof booming demand for labor, pressure on real wage growth was strong

(World Bank, 2009).

Population income grew fast as a result of the employment and wage growth, which brought abouta substantial reduction in poverty in Croatia during the recent few years.

4.

The surge in private investment and consumption, fuelled at large by abundant capitalinflows, raised concerns over the sustainability of the growth pattern.

Although exports growthwas significant lately, import growth (led by capital goods and oil) was much stronger, which,coupled with the terms of trade deterioration, led to the wideningof the current account deficit sothat by 2008, at 9.3 percent of GDP, doubled compared to 2004. Since only half of the currentaccount deficit was financed through non-debt creating inflows, external debt to GDP ratio rose to83 percent in 2008. In addition, with around 90 percent of total corporate debt and about 70percent of household debt in foreign currency or foreign-currency denominated, the country’svulnerability to funding and currency risks remained high.

5.

The global financial turmoil hit Croatian economy at the end of 2008.

After slowing downto 0.2 percent in the last quarter of 2008, the economic activity declined by 5.8 percent in 2009--

the biggest decline since the country’s independence. The decline was broad based, reflecting a fallin personal consumption and gross domestic investment as well as decline in exports in the contextof a deteriorating external environment.

6.

Fiscal position subsequently came under serious stress.

The revenue shortfall and thespending pressure from automaticstabilizers necessitated several revisions of the 2009 budget. Thespending cuts were almost equally distributed across spending categories, except for agriculturalsubsidies. The largest reduction affected: (i) public sector salaries (the rolling back ofthe earlier

3

To 13.2 percent following the national definition, or 8.4 percent as per the ILO methodology.

Responding to additional pressures to protect public finances and inability to reach socialconsensus on further spending rationalization, led the government to introduce new and

increaseexisting taxes4. Despite pro-cyclical impact of these measures through a direct contraction ofconsumption as well as investments, the fiscal situation required rapid moves. Overall, through acombination of expenditure reduction (amounting to 2.1 percent of GDP), and revenue increase(amounting to 0.4 percent GDP), the consolidated general government deficit was kept at around 4percent.

8.

The economic contraction led to a rapid worsening of labor market conditions.

Employment has fallen andunemployment has increased.

The resulting fall in labor incomesquickly translated itself into the rising poverty.

At the same time, due to the budgetary strain, thefiscal space to increase expenditures on social safety net has been extremely limited.

The

rest of thisreport analyses labor market and poverty developments triggered by the economic crisis in moredetail.

II.

Labor Market Impact of the Crisis

9.

The labor market is aprimary transmission channel from theaggregate

demand shock topoverty.

Thissection looks at different forms of labor market adjustment to the current economiccrisis in Croatia.

It traces the evolution of key labor market variables and examines theindustrial andregional patterns of the crisis.

It also identifies the socio-economic profile of workers affected by thecrisis.

10.

The labor market impact of the global economic crisis has beensubstantialin Croatia,although not as dramatic as in some othercountries in the region.

Employment plunged andunemployment increased, albeit less than in most EU countries.

In addition, the labor forceparticipation rate fell, as some workerscame to believe that there are no jobs around and ceasedlooking for jobs (the so calleddiscouraged worker

effect).

Simultaneously, the fall in labor demandwas reflected in the slow-down in real wage growth.

In contrast to some other countries in theregion, working hours adjustment has played a limited role.

As elsewhere, the crisis has affectedmainly the manufacturing, trade and construction sectors.

As

a result,

it was prime age skilled bluecollar male workers who were hit the most by the crisis.

This profile is likely to amplify the povertyimpact of the rising unemployment, because job losses are concentrated among the primaryearners.

There is a strong variation in the crisis’ impact across regions, reflecting the differences inindustrial structure.

While the overall labor market effect of the crisis may seem modest, in someregions it has been quite dramatic.

The crisis triggered layoffs and hasled to an increase in unemployment

11.

The employment effect of the crisis was initially modest but then become substantial overtime.

During the first 12 months of the crisis employment in the corporate sector dropped about 4

4

These include the special ‘solidarity tax’ of 2 to 4% of net income above the HRK 3,000 threshold. The taxapplies until the end of 2010. At the same time, the indexation of pensions was suspended during 2010, whichis estimated to bring 0.2 percent of GDP in savings on pension payments.

17

percent, which was less than thefall of GDP ofclose to

6 percent (Figure1).

Employment thusseemed rather inelastic with respect to the changes in output.

But after some time-lag job losesstarted to accelerate.

In January 2010 employment was already over 7 percent lower than beforethe crisis.5

The initial low elasticity of employment with respect to output,

and associated laborhoarding are likely to be due to the strict employment

However as the crisiscontinued firms no longer could afford to avoid cutting labor costs the pace of job destructionintensified.

This lagged response of employment is likely to have an adverse effect onunemployment.

Strict employment protection legislation, which is behind the lagged employmenteffect, is a double edged sword.

It limits job destruction during the downturn, but it also hinders jobcreation during the upturn.

This implies that the incipient economic recovery in Croatia will probablybring about only modest increase in employment, and accordingly unemployment will begin to fallonly after a substantial time-lag.

This is the historical experience of most countries where firing andhiring costs are high (OECD 2009).

Few employers reacted to the fall in product demand by cutting working time.

The numberof hours worked has remained roughly constant since the crisis has begun, although most recentdata (October 2009) show some reduction in working time (4 percent).

Nonetheless, working timereduction does not seem to be an important adjustment mechanism in Croatia.

If so this suggeststhat short-time working subsidy–

a newly introduced measure meant to support employment infirms affected by the crisis--

may not be an effective tool for averting lay-offs.

On the other handhowever, employers may become more willing to resort to working time reduction if they havefinancial incentives to do so.

The short-time working subsidy program isdiscussed in more detail inSection II.

13.

An important factor that limited the employment impact of the crisiswas

wagemoderation.

Real wages remained virtually stagnant once the economy slowed down and recently(since September 2009) started to fall.

Currently(December

2009)

the average real wage isnearly 3

percent lower than it was a year earlier.6

The reduction of wage pressure helped to cut labor costs

5

This drop partly reflects a seasonal effect. But employment in January 2010 was still 5.8 percent less than in ayear earlier, although already at that time employment was affected by the crisis.

6

See Matkovic and Arandarenko (2010) for a more detailed analysis of wage and employment adjustments.

18

and thus to limit the layoffs.

Wage flexibility has thus emerged as an important crisis impactmitigation mechanism, which is a notable new phenomenon because until recently wage pressurespervaded the Croatian economy and were contributing to high unemployment (World Bank 2008).

14.

The fall in labor demand manifested itself also in a pronounced increase inunemployment.

This increase results from an inflow of both laid-off workers and new labor marketentrants (mainly school leavers) who during the crisis face meager employment chances.7

Thenumber of the registered unemployed is currently (December 2009) about one third higher thanbefore the crisis and over 20 percent higher than a yearearlier (Figure2).However, it should benoted that presentlyregistered unemployment is at a similar level as it was in the late 2006/early2007.

So, the crisis reversed the substantial reduction in unemployment that occurred in 2007 andthe first half of 2008 and moved the Croatian labor market back to a high unemployment state

Figure2: A pronounced increase in unemployment in the wake of the crisis

Panel A.

Panel B.

Source: Croatian Employment Service (HZZ), Bank staff calculations.

15.

The unemployment rate has increased in Croatia less than in the EU, but is above the EUlevel.

Currently, the unemployment rate in Croatia is 10.6 percent (as of December 2009) and is 2.3percentage points higher than before the crisis (December 2008).8

By

comparison, the averageunemployment rate in the EU at 10.2 percent is slightly lower than in Croatia, but increased by 4.1percentage points, that is substantially more.9

So with regard to unemployment Croatia managed towithstand the economic crisis better than in most EU countries.

16.

In addition to an increase in unemployment,

the fall in labor demand has also led to a fallin the labor force participation rate.

Some workers facing the poor employment prospects becomediscouraged and withdraw from the labor force.

The decrease in force participation has not beendramatic, nonetheless significant.

Presently the rate is about 1.6 percentage points lower than it wasbefore the crisis.

Although the increase in unemployment rate and the fall in the labor force

participation rate during the crisis were relatively modest, the combined effect is considerable.

Theemployment/working age population ratio dropped by 2.3 percent in one year from already a verylow pre-crisis level of 57.8 (one of the lowest in Europe).

Raising the low employment/population ratio is one of keychallenges facing Croatia post-crisis.

17.

The increase in unemployment primarily reflects intensified inflows into unemploymentand less so reduced outflows from unemployment to jobs.

Monthly inflows into unemploymentduring the present crisis period are 30 to 40 percent

higher than they were before the crisis.

Outflows from unemployment to jobs fell 20 to 30 percent immediately after the outbreak of thecrisis but recently show some incipient signs of a rebound.

The surge in inflows into theunemployment register implies

a change in the durational structure of unemployment in Croatia: anincrease in the proportion of short-term unemployed and a decrease in the proportion of long-termunemployed.

While the short-term unemployed tend to be “regular” workers who lost their jobsbecause of the crisis, the long-term unemployed tend to be “disadvantaged” workers who arejobless due to the poor skills and morale, limited work experience, etc.

The needs of these twogroups are likely to be different, and thus given limited resources a balance needs to be struckbetween the services provided to each group (OECD 2009).

Fewer job opportunities

18.

In response to the fall in product demand employers have also reduced hiring.

Regions where unemployment was initiallylow have been hit harder by the crisis thanregions where unemployment was high.

After all, there is a strong negative correlation between thepre-crisis unemployment and unemployment growth across regions (Figure4).

The impact of thecrisis in low unemployment regions has been thus significantly stronger than in high unemploymentregions.

On average, in regions where the pre-crisis unemployment rate was around 20 percentunemployment grew about 25 percent, while in regions where pre-crisis unemployment rate wasaround 10 percent unemployment grew about 35 percent, that is 10 percentage points more than inhigh unemployment regions.

This strong negativecorrelation implies that as a result of the crisisregions converged in terms of the unemployment rate.

Presently the variation in the unemploymentrate across regions is much smaller than before the crisis.

Thus the crisis has acted as a labor marketequalizer.

Figure4: Low unemployment regions suffered from the crisis more than high unemploymentregions.

Source: Croatian Employment Service (HZZ), Bank staff calculations.

22

23.

The way regional labor market reacted to the crisisreflects regional industrial structures.

Figure5

shows that industries that were most affected by the crisis include manufacturing, trade,tourism and

construction.11

Accordi ngl y, regi ons where these i ndustri es pl ay a domi nant partsuffered most from the cri si s.

The di fferences i n regi onal i ndustri al structure al so expl ai n whyunempl oyment has i ncreased more i n i ni ti all y l ow-unemployment regi ons.

The strong link between labor market outcomes and povertyimplies that during the crisisadditional anti-poverty measures should be targeted at the newly unemployed.

On the one hand,they should aim at providing temporary income support and improving employment chances and onthe other at preventing the risk of long-term unemployment and the associated erosion of skills andmorale.

The main policy challenge is to prevent the transformation of job loss into labor market

12

See Matkovi c and Arandarenko (2010) for a more detai l ed anal ysis of the soci o-demographi c profi le ofworkers affected by

(World Bank, 2006). About 1 percent of the population facedsevere deprivation by having resources lower than the food poverty line.

The reassessed absolutepoverty rate falls to only 6.1 percent in 2008 (assuming unchanged inequality) or to 8 percent(assuming an increase in inequality of about 10 percent).16

Recoveri ng the poverty trends over the2004-2008 period was found impossible

due to the inconsistency of HBS data over time.

30.

Absolute and relative poverty was also low in Croatia by regional standards.

The incidenceof absolute poverty, using the PPP $5 a day poverty line,at 2 percentis the lowestamongECAcountries for which data is available.

The incidence of relatively poverty (percentage of populationbelow 60 percent of median income), at 18 percent

is close to the EU15 average

(Box2).

31.

Households

saw their economic well-being improve in the years preceding the crisis.

Asubjective assessment of the living standards in the HBS suggests that around 10 percent of thepopulation in 2008 lived in households that faced great difficulties in financing their consumption asoppose to over 13 percent surveyed in 2002 (Table1).

Additional 21 percent of the populationreports to live with difficulty. Overall, around half of the population reports difficulties in matchingtheir needs with the earned income. The subjective poverty is strongly correlated with the relativeposition in the consumption distribution. Of the poorest 10 percent of population in theconsumption distribution, 90 percent report to live with difficulties, while one-third with greatdifficulties.

Box2:

Poverty

is low in Croatia by regional standards

Croati a i s among ECA countri es wi th the l owest i nci dence of absol ute poverty.

decile used about 4 percent of total equivalent consumption, while thetop decile used about 21 percent.

As to incomes,the bottom decile commanded less resources andthe top decile more resources.

This means that while the rich save part of their incomes, the pooractually use their saving to finance the current consumption.

The Gini coefficient also indicates thatincome inequality is higher than consumption inequality. The international comparison suggests thatinequality in both income and consumption remains modest. Although there are no substantivedifferences in inequality between urban and rural part of the country, around half of the country’spopulation live in urban areas, but they command more than 60 percent of total income andconsumption.

17

The poverty gap measures the average di stance between the actual consumpti on of the poor and thepoverty l i ne.

18

The squared poverty gap i s a measure of severi ty of poverty, whi ch takes i nto account di stance from thepoverty l i ne, but i n squared terms, meani ng that hi gher wei ghts i n cal cul ati ons are gi ven to those further awayfrom the poverty l i ne.

27

Table3: Consumption and Income Inequality

Consumpti on

Income

Total

Urban

Rural

Total

Urban

Rural

Consumpti on/i ncome share ofthe bottom deci l e (%)

4.2

4.5

4.6

3.4

3.4

3.8

Consumpti on/i ncome share ofthe top deci l e (%)

20.6

20.4

19.3

21.7

21.1

20.3

Deci l e share rati o (top/bottom)

5.0

4.5

4.2

6.5

6.2

5.3

Gi ni coeffi ci ent

0.236

0.220

0.230

0.270

0.259

0.254

Consumpti on/i ncome share (%)

100.0

60.7

39.3

100.0

61.3

38.7

Popul ati on structure

100.0

52.9

47.1

100.0

52.9

47.1

Source: Estimates based on the 2008 HBS.

Povertyis associated with low educationalattainment and joblessness

34.

Poverty in Croatia is closely related to the family’s socio-economic profile.

Thefamily size

as well as the age, employment statusandthe education attainment of a household headallwere

found to be

important poverty correlates. Gender of the household head, which was an importantpoverty determinant in 1990’s or even in 2004, lost significance in the 2008 survey. This is related tothe improved trend of female employment/participation rate as well as their higher educationalattainment over the last decade. Equally important, the overall education attainment structure ofthe population is improving with almost doubled share of post-secondary education-headedhouseholds (over 15 percent of population)